Strategists, managers at odds over economy’s future

The following edited transcript is from “What This Crisis Means for Long-term Investing: Another Look,” an InvestmentNews webcast held May 26. Deputy editor Evan Cooper and senior editor Jeff Benjamin were the moderators.
InvestmentNews: Let’s start with an introduction from our webcast panelists. Tell us what you’re doing and what you’re seeing out there as far as the markets are concerned.

Mr. Tice: I am a portfolio strategist for bear markets for Federated Investors [Inc. in Boston]. I was a founder of the Prudent Bear Fund [BEARX] and the Prudent Global Income Fund [PSAFX]. My firm sold off those two funds to Federated Investors in early December.

I’m as firmly convinced as ever that this bear market is not over. We simply had a bear market rally inside a secular bear. We believe that we’re going a lot lower, that we’re going to go through the [intraday] 666 low [on the Standard & Poor’s 500 stock index] that we suffered through in March. This does not give me great glee.

I’m sorry not to be more optimistic, but this is what I believe, and why I set up this fund.

Mr. Migliori: I’m co-chief investment officer of RCM Capital Management [LLC] in San Francisco. We are a global asset manager, running over $80 billion worldwide. I am a large-cap portfolio manager as well as co-CIO of our U.S. strategies, and it is our belief that we did see the low in March, at least for the next several years.

Mr. Kleintop: I’m the chief market strategist for LPL Financial [of Boston], the largest independent broker-dealer. What we do at LPL is help advisers leverage their practices. We all know clients want more face time than ever before. They want more action in their portfolios than ever before. They want to be informed about every detail, every investment decision, while advisers are earning less and clients are taking more time to move their assets over.

We were underweight the stock market, underweight beta, for quite a long time, and began to add some risk back to portfolios late in February, and then again in March as well.

So we’re pretty constructive and, like Scott [Migliori], believe we’ve probably seen the closing low back at 676 on the S&P 500. That doesn’t mean it’s all onward and upward from here. We’re probably in a range for a while, but I do think you’ll get some opportunities to continue to add some risk here on the dips. And our outlook continues to be for 1,000 on the S&P 500 by yearend.

InvestmentNews: The S&P 500 is up almost 35% from the March 9 low. Where do you see it going?

Mr. Tice: We see it going to the 400 range, if not below. It’s hard to say how this plays out. We wouldn’t have to get there by the end of the year. There’s going to be a series of declines. I think it’s going to follow somewhat what occurred in the 1930s, where we had the first leg down, then we had a significant rally, and it was followed by seven waterfall declines. Even though there are a lot of differences between now and the 1930s, there are a lot of similarities in that they were both the end of massive asset bubbles. You had everyone in the market — what’s similar is the relationship between greed and fear.

Mr. Migliori: We like to look at it from a weight-of-the-evidence approach, in terms of looking at the positives and negatives. And certainly, in late February and early March, a lot of positives were stacking up. No. 1 is a massive amount of monetary as well as fiscal stimulus. You’ve got interest rates on the short end at essentially zero, and an extremely deep yield curve — we’re talking about 250 basis points be-tween two- and 10-year [Treasuries], which tends to be a very good leading indicator for economic activity. You’ve got initial unemployment claims peaking out over the last several weeks. Again, this has been a very good leading indicator of economic recovery. There’s been a significant amount of credit spread narrowing over the last several months. And there’s also been a peak in inventory-to-sales ratios.

On top of that, early March saw extreme negative sentiment, by any gauge you care to look at, whether it was the [Chicago Board Options Exchange Volatility Index] spiking to record highs or put/call activity. So we were certainly set up for some sort of rally.

Now the question obviously be-comes, how sustainable is it? And because of a lot of these leading indicators, we do expect to see positive [gross domestic product] growth in the United States by the fourth quarter. So with the backing and filling some of our commentators are talking about, I can certainly see the market treading water, or perhaps even giving up 10% or so from current levels. But as we go through the year, and looking into next, I would expect the market to be trading higher from here.

Mr. Kleintop: There are so many data points out there — thousands of them — on the economy, on the different indices, and some of them lead, some of them lag, some are quarterly, some weekly, some monthly. What we’ve tried to do at LPL is focus on what’s most important, and we’ve zeroed in on the weekly data points that tell us where we are right now, related to this financial crisis. We call it the Current Conditions Index. It consists of 10 indicators that we get weekly.

They can range pretty widely. Initial jobless claims, as Scott [Migliori] mentioned, that’s a component. So are shipping rates. A vibrant economy ships around more goods. Retail sales, interbank lending spreads, mortgage applications — all key measures that give us a good reading of where we are right now.

All those indicators bottomed back at the beginning of March. They fell pretty steadily in the first nine weeks of the year, and in the subsequent nine weeks marched steadily higher, and right now they stand at their highest point this year. That’s a pretty good gauge that we are seeing a broad improvement across the economy and good leading indicators of profit growth. That’s encouraging.

And as those indicators continue to improve, that’s going to be something that the market is going to focus on. I think there’s going to be some volatility here in the summer months. We’re going to get the full impact of all those auto-related shutdowns. And we’ve got a number of other issues coming up over the course of the next few months.

The summer always throws a few curveballs at us, including a hurricane season and a number of geopolitical events, which could create some volatility. But as long as this trend in the data continues to move upward — again, this is real-time coincident data on measures of the economy and the markets — then we’re convinced that this is for real, and the 676 we saw on the S&P 500 back in early March will be the low of the cycle.

InvestmentNews: Given that consumer spending accounts for about 70% of GDP, and it seems the consumer is tapped out, with both housing and investment values down, where is the money going to come from to fuel our recovery?

Mr. Tice: David Rosenberg, who just left Merrill Lynch [& Co. Inc. in New York], has come up with a statistic of $20 trillion down from the third quarter of ’07, in terms of decline in consumer net worth. That’s down 30%. If you look at the commensurate decline in the mid-’70s, when we had the horrible ’73-’74 bear market, it was down about 3.6%. Therefore, it’s about eight times greater in percentage terms.

Real estate is still declining. Alan Greenspan [former chairman of the Federal Reserve Board] even came out a couple of days ago and said that real estate hasn’t yet hit bottom. People are hoping lower prices are going to cause buyers to come out of the woodwork. We were already at 75% of Americans owning their homes. We had taken people out of apartments and given them subprime loans.Virtually everybody already has a home. So we just don’t see that coming back. Now, there has been a little bit of an improvement in the economy because it was so far down. However, unemployment is still rising. We believe that the economy is still worsening. The closing of stores and restaurants and retailers is going to continue, and that is going to cause a greater and greater slowdown in profits.

Mr. Kleintop: Absolutely true. There are so many concerns overhanging the consumer right now. If you look at the consumer confidence numbers, they’re absolutely dismal. Americans feel very, very under pressure because of the wealth destruction that David [Tice] talked about.

However, we’re Americans, and when Americans get depressed, what do we do? We go shopping. Take a look at the retail sales numbers. They’ve been remarkably impressive. On a weekly basis, these numbers are hovering pretty much right where they were a year ago. Can you imagine? People still spending exactly what they were a year ago.

Take a look at the first-quarter GDP report. Consumer spending? Positive. Yes, positive, believe it or not. That’s what I’m talking about — a very resilient consumer. There’s no doubt there’s been a lot of wealth destruction and there are a lot of concerns hanging over consumers. That will linger for some time, but that’s never stopped the stock market from bottoming and moving higher. Usually, consumer confidence is very weak, even several months after the market hits a low. And typically, the unemployment rate continues to rise for a year, even two years, after the stock markets bottom. So I think these factors were fully priced in, and we’re actually seeing some improving signs, particularly on the consumer side.

InvestmentNews: If there’s more unemployment and people have less wealth and go shopping, how do they pay the bills?

Mr. Kleintop: Consumer incomes are up, year-over-year. They’re up 3% to 4%. Some people have lost their jobs, but [roughly] 91% are still employed and making more. Whether you look at hourly wages, salaries year-over-year or tax receipts coming into the federal government, taxable incomes are up a little bit, year-over-year. And some of that is the fact that the Consumer Price Index rose a lot last year, so many salary increases were tied to inflation. People got their 3% increase, and maybe they won’t get that this year, with CPI so flat, but we’re still rolling over a lot of these increases from a year ago. Therefore, people have more cash. They’ve just been slower to spend it and less confident in the markets. They haven’t had all of their income wiped out.

Mr. Migliori: A key factor to which David [Tice] alluded is the housing market. That’s the main reason the Fed is engaged in the course they’re in, in terms of quantitative easing, to drive mortgage rates down to a level where you can restructure and re-liquefy the consumer. You’re certainly seeing a lot of that in terms of mortgage [refinancing] activity, and I don’t think we’ve seen the end of that. I think the Fed’s intention, ideally, should be to drive mortgage rates down in the 4.5% or 4.6% range, which I believe would set off massive refinancing.

Mr. Kleintop: We have seen that. Take a look at the mortgage applications data. It has absolutely soared. So Scott [Migliori] is right. That’s a key driver that’s helping the consumer. If you can re-fi and knock down your payments substantially, and lock yourself into a fixed longer-term rate, it makes a lot of sense now. And we’ve certainly seen that helping the bottom line for a lot of households in the United States.

Mr. Tice: Incomes are up a little bit, but that’s because withholding is also down, due to the government stimulus package. Remember, luxury sales were down some 30% for Christmas in ’08. People are spending a little bit more money than we expected. However, there’s been a lot of denial.

As Scott [Migliori] said, 91% of workers still have jobs. However, if you look at the U.S. measure of underemployment, which measures part-time workers that would like full-time jobs, or discouraged workers that want to get back into the work force, that unemployment level is 16.5% or so. So we think consumer spending is going to continue to slow. The pickup in consumer confidence is simply because the stock market’s been up. When the stock market does approach lows again — and, we think, breakthrough lows — consumer confidence is going to fall and people are going to spend less money.

One last thing is the real concern about interest rates. The 10-year bond has gone from 2.6% to 3.6% in just about two-and-a-half months. That’s a dramatic pickup in interest rates.

Mr. Kleintop: And that’s very good news, right? It’s reflective of pricing and better economic growth. The good news is that it hasn’t moved mortgage rates. The 30-year mortgage rate still remains right around 5%, anchored there. If it had pushed up mortgage rates by 1.5%, if we were at 6.5% or 7%, then that would raise some serious issues. I think the fact that it hasn’t [gone up] is noteworthy.

Instead, we’re seeing better real economic growth being priced in, and a more resilient consumer. And yet, you still have the stimulus, as David [Tice] mentioned, with the after-tax incomes rising, in part because of some of those tax benefits. Gas prices that are lower than a year ago are also a benefit — you can’t discount that effect on the consumer pocketbook — and the additional impact of lower refinancing rates.

InvestmentNews: In regard to refinancing, how will a change from around 5% to 4.5% help, since the re-fi market today is a lot different from the re-fi market 18 months ago?

Mr. Kleintop: There is an enormous amount of refinancing that can take place as you break below 5% on a conventional [mortgage]. But even more important, we’ve seen jumbo rates coming down very sharply now, and that’s where you’ve got an even larger group that could really benefit from locking [in] and terming out their mortgages at a lower rate. And there’s just a huge potential driver there. We’ve seen the responsiveness in the re-fi and mortgage applications. That index has soared. It’s already two or three times its normal level. And so, when you’re able to do that and knock a few hundred dollars off your monthly payment, it can do a lot for your confidence.

InvestmentNews: But refinancing only helps people who are already in a position to keep their homes. How does that help the housing market overall?

Mr. Migliori: It does help, in terms of affordability. If you look at the factors in terms of what goes into housing affordability, mortgage rates are certainly a big component of that, as are income levels. So, to the extent that the Fed is successful in pegging interest rates at the long end, and mortgage rates [fall] as a result, the hope and the expected outcome is that the economy does recover, consumer confidence will come back and housing affordability will become attractive relative to a few years ago.

Also, the vast majority of homeowners are still current on their mortgages and able to refinance. There are definitely people who are 90-plus days’ delinquent, or already in the process of foreclosure, who are going to need to rely on the Mortgage Foreclosure Mitigation Plan the government rolled out in March.

The plan is actually proving to be pretty beneficial in getting mortgages restructured, and in some cases even writing off some principal in order to find a mortgage that makes sense for the homeowner. So there is help for those who can’t refinance conventionally.

InvestmentNews: What’s your outlook on the looming problems in the commercial-real-estate market, such as higher vacancy rates and debt coming due, and its effect on the economy?

Mr. Kleintop: Mortgage delinquencies move up, and autos and credit cards, creating a kind of rolling cycle. Commercial real estate is generally at the end of the food chain because leases are longer- term, three years, and fixed, and it usually takes a while to turn those over. Therefore, they generally deteriorate last. And indeed, they are starting to deteriorate and, no doubt, will continue to do so.

The good news is that not much debt is tied to [commercial real estate], even among the banks. There are some mid-tier banks that have some exposure, but for the most part, it’s not securitized, so you don’t have [securities] issues. And you simply don’t have the widespread financial contagion risks that were associated with the mortgage market. The problem is smaller and it’s concentrated in fewer and smaller financial institutions, rather than broadly representing another systemic financial risk.

Mr. Migliori: I would largely agree with Jeff [Kleintop]. When you look at the order of magnitude, in terms of the size of the residential-real-estate market relative to the commercial-real-estate market, it should not be nearly as significant an issue, and it is confined in a number of cases to regional banks, as opposed to being a systemic risk.

Mr. Tice: I believe that it’s a disaster. It’s true that the commercial-real-estate market is not nearly as big as the residential market, but it’s certainly another shoe to drop.

The recent stress tests from the banks were a joke. They benefited from not having mark-to-market rules applied, and very kind assumptions about economic growth were being made.

In regard to residential real estate, there was a roughly 59% drop from the peak in median prices in California.

But most of the mortgages that are on the books, in mortgage-backed securities, as well as at the banks, have been made since ’02. And prices are back to ’02 levels, down about 31% from the peak. We think that the losses are simply massive. The [International Monetary Fund in Washington] came up with $3 trillion potentially at risk for losses inside the U.S. banks, where there is $750 billion in equity.

InvestmentNews: A member of the audience wants to know from David Tice whether running a bear fund makes you a perpetual bear. Are you always bearish? Are there times when you are bullish? Are you institutionally capable of being bullish?

Mr. Tice: I have been a bear since I started my fund in 1996, and that’s because I possess the understanding of economic framework here. This economic framework, that’s very important, is based on the Austrian school of economics, and we’re believers that the credit bubble dynamics which we have benefited from will end in tears. You cannot keep borrowing from the future. Essentially, the Keynesian economic theory, which says that you just stimulate the economy, and as Bob McTeer said back in ’02, everything will be all right if we all hold hands and buy a new SUV, doesn’t work.

I have been bullish in the past and look forward to being bullish again. This is certainly not just an institutional view. This is how I’m advising my friends and family. This is how I’m invested. I started this fund because I felt like that was a way for individuals to make money. And frankly, we’ve made 9% a year over the past 10 years, while the S&P has been flat, so it’s a good way to invest.

InvestmentNews: In regard to government spending, which was mentioned by David Tice, how are we going to get through this economic downturn without facing huge inflation?

Mr. Tice: We’ve had enormous stimulus, and the numbers are enormous in terms of conventional accounting principles, with a budget deficit for ’08 at $5.1 trillion, or 10 times the amount of the reported deficit. This is so much higher because of the buildup in liabilities for health care and the rise in government debt. In fact, the 12-month year-over-year change in debt just came out last week, and it’s up $2 trillion. U.S. government pledges for guarantees and bailouts is at $12.8 trillion.

Richard Fisher [a senior fellow at the International Assessment and Strategy Center of Alexandria, Va.] just came back from China. He was talking about how the Chinese were pressuring him at every turn about this quantitative easing that some people consider a panacea, and the massive amount of debt. His group looks at $99 trillion in terms of liabilities, both on the public side and the private side — a massive amount. And therefore, we do believe that we will destroy the creditworthiness of the United States, and we will destroy our currency, and therefore, it will lead to inflation.

Mr. Kleintop: Certainly, inflation stands out as a major risk as we look out to 2010, maybe 2011 as well. But remember, a lot of the money that the Fed is creating is term money, and what I mean by that is, it expires when its term is up, in 28 days or 84 days, depending on the facility, and then it goes poof — off to money heaven.

And that’s good news in that there’s not much money here that can be left on the table to create a lot of inflation. However, there is a lot of fiscal stimulus. Certainly there’s a lot built into the budget. A $787 billion stimulus package was passed earlier this year, and guess how much of that’s been spent? Like $38 billion. There’s a lot in that pipeline that will no doubt generate economic growth. It will also, no doubt, generate some inflation, so going from zero on the CPI to 3% on the CPI, that’s fine.

I think if you take a look at how much spare labor and capital capacity there is — and by capital I mean factory output, industrial-production capacity — we have an enormous amount. China has an enormous amount. The world has an enormous amount. It’s hard for me to see finished-goods inflation rising, so I think the best investment strategy is to look to buy raw materials, commodities such as some of the basic metals, natural gas, other types of base commodities and metals that are going to feed into this. I think you’ll get a lot of raw-materials inflation, but probably not a lot of finished-goods inflation.

Mr. Migliori: I do think the story for the better part of this year is going to be a deflationary one. We’ve talked about housing prices continuing to decline on the order of 15% to 20%. So Job No. 1, for both the Treasury and the Fed, is to reflate. There’s a long way from reflating out of a deflationary period to inflation of the kind we need to worry about.

But the one thing I do worry about, as David [Tice] has already touched on, is the growing federal deficit. I would argue that perhaps some of his numbers are inflated. But we’re definitely dealing with, at a minimum, a $2 trillion budget deficit this year, and you’re starting to see that create some stress in the system here over the last several days in terms of the decline in the dollar and the spike up in interest rates, as well as what you’ve seen in gold and the other commodities markets. So how do we avoid inflation, how do we avoid the worst-case scenario? I do think it is going to require more monetary restraint, earlier rather than later. I’m talking about in 2010 and 2011. Otherwise we are setting up for an inflationary spiral in the out years.

Mr. Kleintop: But don’t extrapolate the trend. I don’t mean you, Scott [Migliori]. I just mean in general. We have seen an unprecedented amount of red ink, as David [Tice] calls it, just flooding these markets to bail us out and bail the entire global economy out of the financial crisis.

But I think we’re sort of bouncing up against the wall here in terms of public support for additional money. A second stimulus package is now off the table, in part because we’re seeing some green shoots, if you will. And our representatives in Washington are hearing from their constituents that enough is enough, that we have spent enough, and we need to see what this means.

The 2010 elections — believe it or not — are right around the corner. The primaries start early next year. I don’t want to be a Democrat who had to vote for a lot of this stuff, in a Senate seat that’s fairly tightly contested, up for election next year, having poured more and more into these programs. I think that we’re seeing a limit on the amount of spending that’s likely to take place. Indeed, we may not even see all of that $787 billion stimulus package get spent, because the hurdle — the threshold — is getting higher and higher to approve funding. So I’d be careful not to extrapolate these trends in red ink. I think we’ve already seen the maximum amount of money thrown at this problem.

InvestmentNews: Going from the big picture to the small picture, what about people who are between 55 and 60, those on the eve of retirement, with 401(k)s and individual retirement accounts being hit by the market downturn. Where should they be investing?

Mr. Kleintop: Too often, we think about risk versus no risk, stocks versus cash or stocks versus Treasuries. In fact, there are many different ways to get exposure right now. Our recommendation at this time is to focus on fixed income. You’ve got a lot of great opportunities in the bond world right now. High-quality corporate bonds are offering a terrific rate of return, very nice yields. It’s a very attractive place to be, I think, longer term. Non-financial corporate balance sheets look pretty good and, I think, are worth taking on that risk.

There’s some great opportunities on the equity side as well, not just S&P 500 versus cash, but small-cap stocks. They’re most tied to the credit cycle, they’re most dependent upon credit, so we’ve overweighted small- and mid-cap stocks in our allocations. They’re also more domestically focused.

We think Europe’s probably going to be in trouble for quite awhile, so we want to stay domestically focused. It’s a great way to do that. So be overweight small and mid-cap stocks.

Emerging-market stocks, believe it or not, are doing pretty well here, in part because they don’t have the same credit problems we have. They have relatively little debt. They’ve paid a lot of it down. They’re also more raw materials-based. And as I mentioned, I think we’ll see a lot more raw-materials inflation than finished-goods inflation. And then, commodities are a great way to diversify your portfolio.

Also, alternatives are an important tool. We found it invaluable last year to use covered calls, long-short managers, global macro-style managers, to mitigate a lot of the volatility.

All traditional asset classes, so to speak, had a correlation of one. They all fell together, whether it was real estate or commodities or stocks or bonds. What we found is these volatility-loving strategies, like, for example, global macro-style funds, actually were up last year. They can perform a great role in diversifying a portfolio.

So don’t think about it as just stocks versus bonds. I don’t think clients are interested in that anymore. They’re interested in the nuances of exactly how you are going to spend those risk chips. We spend an enormous amount of time thinking about the risk and reward, and think we can put together very intelligent portfolios.

Mr. Migliori: I’m going to answer the question in the context you raised it. Obviously, my answer would be different if you were talking about someone in their 30s. I would certainly recommend emerging markets, and some of the things that Jeff [Kleintop] referenced, but for someone in their late 50s, early 60s, I would be a bit more conservative. While I believe the equity market is attractively valued here, I would probably focus more on higher-quality large-cap companies, companies that let you sleep at night, given what I would perceive to be a lower risk tolerance for that age bracket.

I would argue, however, that I do think high-quality stocks are actually more attractive than high-quality corporate bonds here. The free-cash-flow yields on some of the major high-quality companies are actually at parity with the bond yields, which is a highly unusual occurrence, one which makes equities actually the better value in the market today.

Mr. Tice: Everyone has three legs to their financial stool. There is the paycheck and bonus, and that of their spouse; the home they own, and other real estate; and then there are stocks. In ’08, all three of those legs went down. We believe this is different now, this is not a garden variety recession like we’ve suffered over the last 40 years, and it’s likely all three of those legs are going to continue to go down for another three, four or five years.

Your clients are already wealthy and they already have a pot of money; therefore, they should consider a negatively correlated vehicle that can make money to offset the declines in those other areas. Since your clients lost a lot of money last year, they want to leave a meeting with you feeling that everything’s going to be OK.

InvestmentNews: What about the American auto industry? What do see as the outcome for [General Motors Corp. in Detroit] and Chrysler [LLC in Auburn Hills, Mich.]?

Mr. Tice: It’s very disturbing with the Obama administration essentially overturning contract law, and putting the employees and the retirement plans — the workers — ahead of secured creditors. However, there are going to be a lot fewer cars built in this country, and unfortunately, it’s going to be the same for retailers, movie theaters, hotels, shopping malls and the like. We’re going to have to close down some of this consumer infrastructure. It was built around the system where we all borrowed from the future, we spent far more than we earned, and we did it by borrowing from foreigners. A lot of these companies are going to make a lot less money going forward.

Mr. Migliori: I too find it troubling that you essentially had secured creditors subordinated to the [United Auto Workers]. I do think it was a protectionist move, and somewhat of a political move. Having said that, I don’t think the auto industry is going away. It’s going to continue to evolve, and even though I do think it was somewhat mishandled from an economic standpoint, I don’t think it’s going to have a material impact, or be a material negative, on the economy or the stock market outlook.

Mr. Kleintop: I’m going to agree with Scott [Migliori]. I think this is kind of an isolated issue. I mean, we’ve known about the problems in the auto sector for a very long time, right? These have been brewing for decades, and so we finally have it come to a head. Certainly there are going to be some additional job losses related to the dealerships, and the rationalization of the manufacturing capacity, but this is well known. And in fact, even in the weekly initial jobless claims data, we get a note from the Bureau of Labor Statistics associated with the auto-related layoffs. So as long as those layoffs remain concentrated within the auto sector, I don’t think that’s going to spook the overall stock market. I think that’s priced in, and certainly expected.

Look at all the broader trends we’ve mentioned, the improvement in recent weeks and months in the labor market: Layoff announcements peaked in January of this year, and have steadily come down; we’ve gone from 700,000 jobs lost per month in January, to 600,000 or so in February and March; now only 539,000 in April — that’s still a terrible number, but improving. As long as those numbers don’t dramatically reverse as the auto-related layoffs widen, then I think we’re OK. So, I think the issue is isolated.

InvestmentNews: It looks like a large chunk of the American auto industry is nearing some version of extinction. Isn’t that a pretty big isolated issue?

Mr. Kleintop: Not so much. It used to be — as goes Detroit, so goes the U.S. economy. That’s no longer the case. Less than one percent of our labor force is employed in autos. We’ve got a relatively small amount of our productive capacity in there.

Let’s face it, they haven’t been running at full capacity for quite some time. So as they ratchet this down over the course of the next couple of years, to a more reasonable rate of auto production — not zero, but it’s certainly not where they’ve been for the last few years — the impact will be incremental. But again, this is something that’s been well-known for quite some time. We have seen job losses in the auto sector for many, many years — decades now. It’s just an extension of that trend, one that I think is pretty well-reflected in the expectations for the economy and the markets.

InvestmentNews: In regard to the earlier discussion about retirees, in weighting the demands for preserving principal and getting some decent returns, what allocation do you recommend for a person who is already retired, somebody, for example, who is 70 or 75?

Mr. Kleintop: The municipal-bond market is very attractive right now, and you can get pretty good yields there, so if this person is taxable and retired, and we’re talking about their taxable money, then I think that is a pretty attractive mix of relatively low risk for a pretty good yield right now.

For a non-taxable account, I would suggest corporate bonds. Take a look at some of these yields — 7%, 8% for high-quality corporate issuers. That’s pretty attractive. We will see defaults rise, as they usually lag the economic cycle, but that’s more than priced in, so you can get a fairly attractive return in a portfolio that’s very focused on keeping volatility down.

For some portion of that portfolio that might go into the equity markets, I would suggest a strategy that really limits volatility. Again, there are some of these strategies, like covered calls, that are an interesting way to benefit and create some yield out of an equity portion of a portfolio. But most important, be flexible.

Take an approach that’s very adaptive. I don’t think “buy and hold” makes sense here forever. You’ve got to take advantage of the opportunities that are given to you.

Mr. Migliori: It wouldn’t be that different. I do think municipal bonds make sense, but certainly be diversified in that approach. Perhaps I’m biased, living in California, where we have our own problems at the moment. So I’d certainly be very diversified geographically. Again, I think large-cap quality stocks are a good place to be, even more attractive than bonds, but beyond that, I really don’t have an issue with what Jeff [Kleintop] laid out.

Mr. Tice: I would just say, safety, safety, safety. And this: Be very, very careful. And I would not underestimate the risk of corporate bonds. Spreads went up a lot earlier, six months ago, and they’ve returned to more normal levels. I think spreads are going to blow out again. I do think there are going to be a lot more corporate defaults than people are expecting.

Most of the corporate bonds that have been issued these days are not investment-grade. A dramatic percentage of bonds are in the high-yield area because so many companies have issued them.

And as far as munis are concerned, there are going to be immediate problems. Just look at California. A lot of the cities are going to have problems. The question is, whether the government going to jump in. It looks like the government’s going to jump in behind California. We know New York and New Jersey have massive problems. It’s probably going to be another bailout, but there you run the risk of rates going a lot higher, if foreigners balk at buying all this paper we’re creating.

InvestmentNews: A member of our audience wants to know where [Treasury inflation protected securities] fit in, in terms of protection and returns.

Mr. Kleintop: TIPS are obviously a great way to protect from inflation, but I think, in 2009, that’s probably not the way to go. Treasury yields have certainly moved up. And remember, a big portion of what you’re getting in a TIPS is the Treasury. So as rates rise, you suffer some losses. And with inflation very low, you’re not getting a whole lot.

A year or two from now, TIPS may make some sense in a portfolio. Right now, I’d shy away from Treasuries. Focus more on the corporate-bond market, where you get not only the interest-rate side of it, but a fairly wide credit spread, and that will help limit some of the potential negative impact from rising interest rates.

Mr. Migliori: To the extent you’re looking to protect against inflation, there are probably better vehicles, such as ETFs. I don’t have any preconceived biases as to which I’d prefer, but certainly precious metals, energy-related, any hard asset that is going to appreciate as the dollar depreciates. The SPDR Gold Trust ETF (GLD) from State Street Global Advisors in Boston is one ETF, for example. There are energy-related ETFs that would be probably a better hedge against inflation than TIPS at the moment.

Mr. Tice: I would tend to agree as far as liking precious metals better. I believe precious metals ought to be in every portfolio. [The GLD ETF] is a decent play. It’s an ETF that invests in gold bullion.

But we like the mining companies better. Some of my co-panelists have talked about commodities, and other commodity-oriented stocks. I’d certainly like those a lot better than industrial- and consumer-related companies. However, we believe there’s a tug of war going on between deflation and inflation. We think it eventually ends with inflation winning; however, there will be some deflationary scares along the way. With the economy slowing, we like precious metals better than industrial-based metals.

InvestmentNews: Can inflation and deflation exist at the same time — the worst of both worlds, where asset prices decline and prices for food and medical care, for example, rise?

Mr. Tice: That’s what we believe will occur. There will be deflating asset prices, real estate will continue to decline and stock prices will decline. With a lower U.S. dollar, given that most of our consumer goods are imported, prices are going to rise, and therefore, we could certainly get into a stagflation scenario.

Mr. Migliori: I do think that is the bear case. If I had to worry about something, that would be it: continued deflationary pressures on housing and an uncontrolled decline in the dollar, resulting in inflationary pressures, at least in terms of commodity-oriented inflation.

At this point, I think that’s an unlikely outcome. The Fed and the Treasury have taken the means and the measures to have a controlled decline in the dollar, which actually is a positive for multinational companies here in the United States from a growth perspective. And I think we’re far away from seeing any kind of uncontrolled decline in the dollar.

Mr. Kleintop: Stagflation periods in the past were the result of policy mistakes. And it appears, so far, those same policy mistakes are not being made.

InvestmentNews: Can the 1930s happen again? Can those mistakes be repeated?

Mr. Kleintop: Certainly, there’s room for more mistakes, and we’ll see another credit crisis. We get one every 10 years.

In the meantime, I think we’ve allocated the resources appropriately to get out of this one. Future mistakes will be made, but I don’t think we’ll be making them back-to-back this time.

Mr. Tice: Remember that [Treasury Secretary Timothy] Geithner was the one who supervised the New York banks, so let’s not get full of ourselves in terms of thinking about the brilliant policy responses so far.

In terms of the mortgage market, as mentioned before, it’s getting a little better. That’s because the Fed is in, buying a trillion dollars of mortgage-backed securities and agencies. [Former Fed Chairman] Paul Volcker recently said the entire financial system is functioning due to the good graces of government intervention. This is not a healthy economy, and this is truly a science experiment. We’ll see how it works out.

InvestmentNews: It sounds kind of scary when you talk about it that way. What if things don’t work out well? What will life be like 10 years from now if it doesn’t work out the way the policymakers say it will?

Mr. Tice: Unfortunately, what it means is that the United States is going to face a standard-of-living pay cut. And remember, there are only 300 million Americans, and 6.5 billion total citizens in the world. Until now, we have essentially driven the global economy.

We will have a prosperous global economy down the road, but I think it’s going to be more and more geared toward an Asia-centric growth model, and the Chinese going from eating rice to chicken to beef. And we are not going to be the tail wagging the dog, where Californians live in $600,000 median homes. And we’re going to have to get used to a lot less consumer infrastructure, and people sharing chocolate chip cookies around the breakfast table with their neighbors.

Mr. Kleintop: One of the things I think we can agree on is that there’s going to be a lot more Asia-centric growth going forward. And I think there are two twin engines to the global economy, the United States and China, and the United States in some ways is giving up some of its edge to China.

But the United States is still the world’s largest manufacturer. We still export more manufactured products than China does. We’ve still got a huge advantage in terms of size, scope, productivity and output over China. So we’re not just flipping a light switch here, and it all goes to China.

There’s room, perhaps, for both economies to benefit from this. We certainly have a lot to offer a Chinese consumer, in terms of our products, in terms of our intellectual property. And we can certainly benefit from that tremendous move, as well. The more consumers in the world economy, I think, the better all countries are going to be.

Mr. Migliori: A lot depends on a time horizon. The story of the remainder of 2009, as well as 2010, is global recovery. In the United States, I think we’ll be at the forefront of that, primarily because we’re taking the most aggressive action to reflate and to re-stimulate the economy. Some of the issues that David [Tice] has brought out are possible in 2011 and 2012, in terms of debt becoming a significant issue from a future growth standpoint.

And it’s going to require some discipline from both our Treasury secretary and our Fed chairman to take the foot off the gas pedal, to decelerate in terms of stimulation policies in the 2011-2012 time frame. And only time will tell whether they deliver on that. But in the meantime, I think you have a very attractive valuation backdrop here in the United States, as well as attractive growth prospects globally.

Longer-term, the best growth rates are going to be in emerging markets. They are going to be more volatile, however, and timing, again, is everything. But I do think that, in the next one or two years, there’s going to be a recovery story before we need to worry about the fallout of some of the policies we’re embarking upon.